Business Law & Compliance
Navigating corporate governance in a family business
6 min read
07 October 2016
Recent headlines encapsulate the tension between decisions made according to the family business agenda and those obligations which begin on incorporation and intensify with growth. To family firm owners this is an ever evolving scale and begs the question: at what point do the interests of external stakeholders take primacy?
Section 172 of the Companies Act 2006 creates a legal duty that as a director I promote the success of the company for the benefit of its members as a whole, whilst also taking heed of any long-term consequences of decisions and the impact on the interests of other stakeholders such as employees, suppliers, customers and communities. However, for family owned and managed businesses, this obligation may at times conflict with those interests of the family – take, for example, the hiring of a family member who might not have the requisite skills to fulfil their job.
Perhaps I can legitimise the hiring of a family member with the argument that succession planning is in the best interests of the company, or maybe that the trust between myself and these parties form a vital part of a good business relationship. There may in fact be a multitude of legitimate reasons for hiring someone with a close relationship, or perhaps not, but it’s not illegal to hire someone who might be deemed a “related party” unless their gross incompetence would constitute a breach of the duties I owe as a director to the company when making the decision to hire. It is, after all, my company. Is the hire, however, in its interests? Can this person promote the success of the company without competing interests?
Another issue would arise where, rather than hire the family member, I’ve decided to create a trading relationship with them causing others to question its legitimacy in nature. Can the terms of arrangement between this family member and myself ever be truly at “arm’s length”?
Arm’s length transactions are enshrined in contract law and the principle is that, for a transaction to be at arm’s length, opposite contracting parties should act independently to each other. This ensures that all parties are acting in their own self-interest, are not subject to any pressure or duress from the other parties, and are dealing from equal bargaining positions. Two strangers with equal bargaining power are likely to agree upon a price that is close to market value, and therefore it’s assumed that an arm’s length transaction will be fair and equitable to all parties involved and will result in a fair market sales price. Where transactions are not at arm’s length, conflicts of interest may be present and suspicion can arise that the terms were not, in fact, negotiated or recorded on fair terms.
Although transactions not at arm’s length are not prevented by law, specific obligations are imposed on me to disclose and manage any conflicts of interest that arise. For example, many financial reporting frameworks, including UK GAAP (Generally Accepted Accounting Practice) and IFRS (International Financial Reporting Standards), include specific requirements in respect of accounting for and disclosing related party relationships, transactions and balances.
As my business grows in size, additional disclosures and more stringent rules will apply to relationships and transactions between the entity and related parties in order to enable users of the financial statements to understand their nature and the actual or potential effects on the business. Providing a true and fair view in the companies’ financial statements is important to any existing or future investors, the public and government agencies, eg HMRC.
As a company grows, owners like me will find that business decisions recorded within the company’s financial accounts and reports come under more and more scrutiny. As a result, a step change will be essential to my corporate reporting strategy as a reflection of my company’s growth.
In sum, the answer to the question of supremacy is, ultimately, left to my discretion in light of the duties and disclosures I owe as owner and director. However, transparency is key when balancing the scale. Where the interests of the family may compete with those of the company, good corporate governance would be to disclose and record consideration of these issues for example, through board minutes or resolutions of the directors (or if constituted, an audit or ethics committee). Where I transact with related parties, the law also requires I disclose it in accounts. This audit trail provides transparency to the outside world and ultimately ensures compliance in what is a rapidly changing regulatory environment for businesses like mine.
Joan Medland is senior associate and Matt Timmons is a director in PwC’s entity governance and compliance team.